A Look at Global Financial Markets 09.01.23
This Investment Strategy update aims to provide clients with a comprehensive picture of the global economy and regular updates on the current stock market and fixed-income trends, to assist investors in making informed investment decisions. It is headed by Tom Elliott, deVere's International Investment Strategist, who produces regular updates on a wide range of topical investment issues. Please find below the update from 9th January 2023.
Market sentiment: A solid start to the year. Last week’s rally across global stock markets reflected hope that global interest rates may not have to rise as much as feared, leading to a less server downturn for the global economy this year than had been forecasted. Major government bond markets rallied.
The good news came from the US and Eurozone. In the US, average hourly wage growth fell in December, despite stronger than expected new jobs growth. If pay growth continues to decline, the Fed can worry less about the risk of a pay-driven inflation problem emerging. US interest rates may peak, and then start to be reduced, sooner than the Fed is currently forecasting, and the likelihood of a soft landing for the US economy increases. Falls in December Eurozone inflation, reported last week, reflect recent falls in energy prices – unambiguously good news for the region’s growth, as well as reducing the pressure on the ECB to raise interest rates much further.
Beware of cherry picking US jobs data. Investors should be careful not to read too much into the fall in US average hourly wages reported last week, from 4.8% in November to 4.6% in December. Ie, not to cherry pick data that helps build a scenario that they wish for, while ignoring less supportive data. It is true that the JOLT jobs report, as well as non-farm payroll growth, are both reporting consistently fewer jobs growth numbers as the months go by. This supports a narrative of a jobs market that is coming off the boil. But the data still shows net increase in hiring. With no increase in the labour force participation rate, it is hard to see the fall in wage growth as anything other than a temporary blip in what is a volatile data set. The unemployment rate has fallen to a 50-year low of 3.5%. We may yet see a rebound in pay growth before it begins a structural decline.
China re-opening- deflationary or inflationary? As the world’s second largest economy gradually re-opens, economists are wondering about the likely impact on global inflation. Could China re-ignite inflation next year, just as it is rolling-over in the western economies?
Bottlenecks in the supply of manufactured goods (such as iPhones) will ease, helping to reduce prices in global traded goods. But pent-up domestic demand, in China, for manufactured goods could be strong and lift global prices. Chinese demand growth might also push commodity prices higher, especially metals. There is a further complication: what if the expected rise in Covid cases, and deaths, deters consumption, hirings and investment, irrespective of the message coming from Beijing?
Terminal interest rates – are we nearly there? In the U.S, the Fed’s own rate-setting committee expect to be raising rates into the second half of next year, perhaps completing at around 5.1% by the fourth quarter (from the current target rate of 4.25%-4.5%). No cut is expected until early 2024. The market takes a different view, with the Fed Funds futures pricing in at least one 25bp rate cut in the second half of this year.
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Consensus expectations are for the Bank of England and the ECB to both take interest rates another 1% higher by mid-2023, taking the U.K bank rate to 4.5% and the ECB’s deposit rate to around 3%.
Interestingly, the 10yr Treasury currently offers a yield 0.69% lower than the 2yr Treasury (as of 6/1/23). This is the largest inversion of this part of the yield curve since 1980, and to many analysts it is a harbinger of recession (why else would a long-term investor be willing to lock themselves in at a lower yield than a two-year investor?).
‘A game of two halves’- an outlook for markets in 2023. There is a widely-held view amongst many of the sell-side (ie, investment bank analysts) that a weak first halve of the year for risk assets will be followed by a recovery, built on anticipation of the next economic cycle.
They are looking at a weak first halve of the year as G7 growth stalls and interest rates continue to rise. Corporate earnings will disappoint, and what investors will pay for those earnings will come down (ie, the price/earnings valuation). Growth-orientated stock markets, such as the U.S, look particularly vulnerable, given their current valuations.
‘Peak misery’ might be late spring. Unemployment will be rising and there will still be aggressive language from the central banks on the need to stamp out inflation -which by then will be sharply down from current levels, but still well above the 2% target set by the central banks. This is, perhaps, when stocks will reach their cyclical bottom, and when investors might be rewarded for taking the plunge.
In contrast, the second half might see risk assets start to price in a cyclical upturn in the G7 economies, beginning late 2023/ early 2024. The assets that have fallen hardest between now and then may be the strongest performers during this recovery rally, with the best performing days probably at the start. Then will be cyclically-sensitive sectors, such as industrials, consumer discretionary and autos. What might trigger this recovery? Probably central banks’ ending of rate hikes, and easing of rhetoric on inflation, as it slowly makes its way down to the 2% target rate in the major western economies, together with signs of economic stabilisation.
Investors should remain diversified. There is no ‘right way’ to approach investing, since each individuals attitude to risk, and time horizon, differs. However, a disciplined approach to putting money into the markets, that ignores current trends the markets, when the outlook for corporate earnings and interest rates is so opaque. Investors should remain diversified in multi-asset portfolios, that offer exposure to equities, bonds and alternative asset classes. Holding cash is tempting, but it suggests an ability to ‘time the market’, to invest it at an optimum point in the cycle. See below for why this is near-impossible.
Stay well!
deVere's International Investment Strategist